We are still at the very beginning of September and already much regulatory change is brewing for AIFMs and UCITS funds.
On September 2nd 2019, ESMA published its new guidelines on liquidity stress testing in UCITS and AIFs (the “guidelines”) which will take effect from September 30th 2020. The guidelines set down minimum standards for liquidity stress testing (“LST”) in EU domiciled UCITS and AIF funds. It is therefore no surprise that last month the Central Bank of Ireland (CBI) issued a “Dear CEO” letter to all UCITS management companies (“ManCo”) and AIFMs noting its expectations that the board, relevant directors and designated persons of each ManCo assess the liquidity position of each fund under management on an ongoing basis to ensure “that the liquidity of the investment portfolio remains in line with the respective fund’s redemption policy, taking into account investors redemption demands”.
Under the existing UCITS framework, UCITS ManCos are required to conduct stress testing where appropriate to assess the liquidity risk of a UCITS under stressed circumstances. Under the existing AIFMD framework, AIFMs are required to “regularly conduct stress tests, under normal and exceptional liquidity conditions, to allow the AIFM to assess the liquidity risk of each AIF under management and monitor the liquidity risk of each AIF accordingly”.
The new guidelines set down a principle-based approach to LST in order for ManCos to tailor their LST framework to allow for the nature, scale and complexity of funds under management. The guidelines provide that LST should be adapted appropriately for each fund by applying flexibility with regards to the frequency of stress testing and the types and severity of scenarios used. It is clear from the new guidelines that ManCos should avoid reliance on the delegated portfolio manager’s own LST. Therefore, any ManCo with an appointed investment manager should ensure that the delegated manager provides adequate information to allow an appropriate LST by the ManCo.
Stress testing is required to be conducted at least annually (which is the minimum frequency set down under AIFMD), however, ESMA recommends in the guidelines that stress testing should be conducted at least quarterly. The frequency of stress testing should be based on the nature, scale, complexity and liquidity profile of the fund. In the case of a suspected material liquidity risk, ad-hoc stress testing must also be carried out “as soon as practicable”. If the stress testing confirms material risks, the Management Company should notify its national competent authority (“NCA”) of same.
The new guidelines aim to set down a common framework for LST carried out on EU domiciled funds. This should, in turn, increase the standard of liquidity stress testing by ManCos and promote consistency in the way in which NCAs supervise fund liquidity stress testing across the EU. Furthermore, the benefits for ManCos are that the guidelines will help to ensure that the fund is liquid, ensure that liquidity is managed to the best interests of investors, help identify weaknesses of an investment strategy and assist risk monitoring.
ManCos must be able to demonstrate to their NCA that the fund is structured so that it will remain sufficiently liquid during stressed market conditions. From September 30th 2020, where possible, LST should be conducted via model portfolios at the product development stage and as part of decision making prior to fund launch.
The factors which need to be taken into account in the design of the LST are:
(i) the LST models and assumptions underpinning them should be validated independently from the portfolio management function; (Note: the entity/person performing the validation need not be external to the ManCo)
(ii) both historical and hypothetical scenarios should be used. There should not be an over-reliance on historical data given that future stresses may differ from previous stresses and historical data may not provide sufficiently severe examples of stressed conditions and
(iii) reverse stress testing should be used where appropriate.
The LST must stress test both assets and liabilities of the fund. Both the liquidation cost approach and/or the time to liquidity approaches should be used. Through the LST the ManCo should be able to determine whether liquidation of a particular asset is at all possible, taking into account factors set down in the guidelines.
Scenarios relating to redemptions, derivative margin calls, committed capital and interest rate sensitivity should also be included. The ManCo should also aggregate LST across funds under its management where appropriate and particularly where more than one fund has similar strategies or exposures.
It’s worth noting that not all EU domiciled funds fall within the scope of the guidelines. EU domiciled money market funds (“MMFs”) will only be subject to certain guidelines which are not already addressed under the Money Market Fund Regulations (“MMFR”) regulatory framework.
That was the regulatory change news of September 2nd, then one day later on September 3rd, the United Kingdom’s Financial Conduct Authority (“FCA”) updated its webpage on the national private placement regime (“NPPR”) to announce changes to submission of Alternative Investment Fund Manager (“AIFM”) notifications. The NPPR permits AIFMs to market AIFs that cannot otherwise be marketed in the EEA. From today the FCA is introducing changes to the submission of notifications by AIFMs marketing alternative investment funds (“AIFs”) under regulations 57, 58 and 59 of the UK AIFM Regulations 2013. In broad terms, the changes include:
- AIFMs marketing funds under regulations 58, 59 and, for UK AIFMs only, regulation 57, will return to submitting notifications via the FCA’s Connect platform
- New forms will be in place for full-scope EEA AIFMs marketing AIFs under regulation 57.
Then there is the September 15th deadline, for UK managers in Luxembourg to submit their firms intent to continue providing services in Luxembourg after a hard Brexit. If the notification isn’t submitted via the CSSF website before September 15th then managers have until October 31st 2019 to submit to the CSSF either an application for authorisation, information on the nature of the activities they intend to pursue after the occurrence of a no-deal Brexit, or the steps they have undertaken to address the loss of passporting rights.